Gentex Corporation (GNTX), by far the leading auto-dimming mirror manufacturer with 88% market share, has seen its stock rise by as much as over 30% this year, far outpacing the S&P 500. Although the stock is slightly undervalued, there are still several critical strategic issues that need to be examined regardless of valuation. Of particular concern is the threat of cameras replacing mirrors. We have long believed that this is too far in the future to be a threat to buying the stock, and new research supports this opinion.
Background and Valuation
Chairman and CEO Fred Bauer founded Gentex in 1974 to manufacture smoke-detection equipment in commercial buildings, a business it still operates today. The company moved into auto-dimming electromechanical vehicle mirrors in 1982, and in 1987 Gentex became the first auto supplier to bring electrochromic technology to the sector. Gentex has been able to use this first-mover advantage and a very consistent manufacturing process to increase its share of the auto-dimming mirror market to 88% in 2012 from 77% in 2003. Although Gentex owns nearly 700 patents related to its mirror business, the company still has to compete with its main rival, Magna (MGA), on every new vehicle program. The consistent quality and reliability of Gentex’s manufacturing process enables Gentex to increase share off of an already large base and earn a narrow economic moat. In 2011 the company posted $1 billion in total revenue for the first time and 2012’s top line was $1.1 billion with 23.8 million mirrors shipped, compared with 8.8 million units in 2002. Gentex’s compound annual revenue growth since 2002 is an impressive 10.8%. The company’s free cash flow and return on invested capital, or ROIC, are also outstanding for a parts supplier, with ROIC typically at about 20%-25% and only declining to about 17% in 2009 during the global recession. Free cash flow, defined as cash from operations less capital expenditures, has averaged 81% of net income since 2002, so the company has very high earnings quality as well as a fortress balance sheet with no debt, no unions, no pension or OPEB, and $4.73 per diluted share of cash and investments as of March 31. Despite Gentex’s positive attributes, we do not see it earning a wide moat, since, like all auto suppliers, it still has to give automakers annual price reductions and is subject to the cyclicality of the auto industry.